Merz accused of using debt bazooka for welfare and tax cuts instead of investment
Two prominent institutes and the Bundesbank sound alarm over use of new borrowings
German Chancellor Friedrich Merz has been accused by economists of channelling billions of euros of new debt intended for defence and infrastructure investments to fund a higher welfare budget and other ongoing expenditures.
The Bundesbank and two economic think-tanks have warned that a sizeable portion of the government’s planned additional borrowing was likely to be used for areas that should be funded from the ordinary budget — also including tax cuts or subsidies.
After winning Germany’s federal elections in February, Merz struck a landmark deal with the Social Democrats and the Greens to loosen the country’s constitutional borrowing limit for infrastructure and defence spending.
The new rules opened the door to up to €1tn of additional investment in these two areas over the next decade, which is expected to boost GDP growth after four years of stagnation. The debt brake, which limits borrowing to 0.35 per cent of GDP in any given year, continues to apply for the rest of the budget.
German Economic Institute IW — a think-tank funded by employers’ associations — is the latest to raise concerns, suggesting that at least 40 per cent of planned additional debt by 2029 will be used to plug holes in the ordinary budget.
Merz’s coalition was using “a whole range of subterfuge” to work around rules stipulating that the additional borrowing has to be spent on extra investment in defence and infrastructure, IW said in a research note published on Monday — just weeks before the German parliament is scheduled to vote on the 2026 budget.
“This budgetary shell game risks undermining Germany’s future competitiveness,” said IW economist Tobias Hentze.
According to IW’s estimates, Berlin is planning to borrow an additional €271bn by 2029 compared with previous medium-term plans. Only €164bn of those funds are earmarked for the military or infrastructure investment. The remaining €107bn will be used to fund other government expenditures such as tax cuts for the hospitality sector and higher pensions for non-working mothers, it claimed.
Bundesbank also warned earlier this year that the government’s additional borrowing “is being used to a considerable degree to create other fiscal leeway”, suggesting that debt will rise “without an equivalent increase in defence capabilities and infrastructure”.
The central bank is forecasting that Germany’s budget deficit will rise to 3.5 per cent of GDP next year and rise further to around 4 per cent subsequently, up from around 2 per cent in 2025.
Similarly, Munich-based think-tank Ifo said in September that “key investment projects in the core budget are being cut and shifted to special funds” after carrying out a detailed analysis of more than 5,700 individual budget items. Social and defence spending were “rising noticeably”, it said.
Berlin was stretching the new borrowing rules “far beyond what had been politically agreed”, claimed Danyal Bayaz, Green finance minister of the state of Baden-Württemberg, warning that this was a “brazen” move that will blunt the expected positive effects on growth. “A lot of the money is flowing into measures that neither strengthen our infrastructure nor improve our competitiveness,” said Bayaz.
Sebastian Dullien, research director of economic think-tank IMK in Berlin, which is funded by German trade unions, said the finance ministry is technically meeting the requirements set in the law. But he noted that what actually can be classified as additional investment was ill-defined and easy to game.
He stressed, however, that the short-term effects on GDP growth would not be blunted. “In macroeconomic terms it is largely irrelevant in the short run whether the money is used for investment or other spending,” he said.
Asked for a comment, the finance ministry said that all budgets until 2029 would meet the rules set in the constitutional change. These dictate that at least 10 per cent of the core budget will be used for investment.
Any amount beyond that is deemed “additional” and is entitled to be covered by the country’s new €500bn infrastructure fund. “Shifts between the core budget and special funds were made where they were technically justified and sensible,” a spokesman said.
Armin Steinbach, chief economist at the finance ministry, took issue with some of the reports’ methodology, suggesting they used as a benchmark “inflated planned investment figures” that predated the creation of the €500bn infrastructure fund.
He also said assumptions had been made that €100bn of the €500bn fund — which will be allocated to federal states — would not be used for investment “which is not a given”.